CBN’s new forex policy can make Nigeria adjust to lower oil prices – Fitch Ratings

By Sylvester Ugwuanyi on June 18, 2016

A leading global rating agency, Fitch Ratings, has lauded the decision of the Central Bank of Nigeria, CBN, to end currency peg, saying that the shift to a more flexible foreign-exchange regime will not only support growth but could help the country to adjust to lower oil prices.

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In a statement issued yesterday, Fitch however warned that implementation of the new forex policy may present challenges if not properly managed, explaining that establishing the new framework’s credibility would be key to its effectiveness in attracting portfolio flows and Foreign Direct Investments, FDIs, to make up for lower oil export receipts.

Fitch Ratings further stated that the CBN’s previous policy of restricting access to the official FX market and supporting the naira has been negative for Nigeria’s sovereign credit profile rather than risk the inflationary impact of devaluation.

It also pointed out that defending the naira has lowered reserves and increased external vulnerabilities, while a shortage of hard currency has weighed on the non-oil economy.

The agency maintained that the change of policy was consistent with its view that the CBN would struggle to defend the naira indefinitely.

The statement reads, “But a backlog of unmet dollar demand (estimates range from $4billion to $9billion) has built up and any inability to clear a significant portion of that backlog early in the transition would hinder the effectiveness of the new framework. The CBN will introduce a new non-deliverable forward to try to limit exchange-rate volatility under the new system, by moving some of the dollar demand to the futures market and away from the spot market.

“Even so, the CBN will probably have to deploy a large portion of its international reserves during the first week(s) of implementation. It also reserves the right to intervene by buying and selling FX to smooth market movements, although it has made no specific announcements about trading bands or break points that might lead to intervention. Nigeria’s unorthodox FX policy has made raising external financing more difficult.

“Allowing the market to determine the value of the naira could ease this, although we think much potential FDI may remain on the sidelines until a clearer picture emerges of how the new system is functioning. Foreign investment in the domestic bond market is very low and not likely to increase in the near term. High demand for FX after devaluation may also limit the benefit to the current account from recovering oil prices.”

Fitch, which stated that an increase in FX liquidity would support a potential recovery in growth in second half of 2016, observed that “Nigeria’s GDP contracted 0.36 per cent year-on-year in the first three months of this year, and we think this contraction has probably continued in second quarter of 2016 due to hard currency shortages, and unrest in the Niger Delta lowering oil production.

“Naira devaluation could lead to a further spike in inflation, which rose to a six-year high of 15.6 per cent in May. But we think the inflation pass-through from the official rate is limited and a fall in the parallel rate would be deflationary, which along with the increasing availability of hard currency could lower inflation.

“We will assess the implications of Nigeria’s new exchange rate policy on its economy and external finances as part of our next review of the country’s ‘BB-‘/Negative sovereign rating. Our base case for Nigerian banks is that regulatory total capital ratios will not decline significantly under the new regime. Any impact will be offset by still strong profitability and high levels of internal capital generation. The new FX regime crucially also provides access to US dollars for the banks to meet their internal and external obligations.”